Chapter 8 Growth companies

1. Corporate Financial Strategy4th edition Dr Ruth Bender Chapter 8Growth companies

2. Growth companies: contents • Learning objectives • Financial strategy for a growth business • Growth companies require a marketing focus • Growth equity carries different risks to start-up equity • Capital asset pricing model • Dividend growth model • Project risk and return • Foregone low-risk opportunities • Rights issue • Bonus issue

3. Learning objectives • Explain how the life cycle model relates to a company in the growth stages of its life. • Critique the financial strategy adopted by a growth company, making a decision as to which aspects of the life cycle model are relevant to its circumstances, and why. • Appreciate some of the assumptions behind the Capital Asset Pricing Model, and their flaws. • Calculate the theoretical impact of rights issues, bonus issues and share splits, and understand their likely effect on corporate value.

4. Financial strategy for a growth business

5. £ 0 Time Growth companies require a marketing focus Focus on building market share in order to be a major player by the time it starts to mature

6. Growth equity carries different risks to start-up equity Required return Start-up equity, provided by venture capital Growth equity, often provided by IPO Perceived risk

7. Capital asset pricing model

8. Dividend growth model Ke is the shareholders’ required return D1 is the next dividend to be paid P is the current share price G is the future compound growth in dividends

9. Project risk and return Project A should be accepted, as it generates more return than its cost of capital. Project B should be rejected, as it generates less return than its cost of capital Project expected return B A Company overall risk factor Project risk

10. Foregone low-risk opportunities Minimum return Foregone low-risk opportunities Company overall risk factor Project risk

11. Rights issue • In a rights issue, existing shareholder have the right to subscribe for new shares in proportion to their existing holding • For example, a 1 for 4 issue at 45p means that for every 4 shares held, the shareholder has the right to buy one extra share at 45p • If the shareholder chooses not to take up the rights, they are sold by the company in the market, and the shareholder receives the net proceeds • The theoretical post-rights price can be calculated. The actual post-rights price will differ from this due to investors’ views on the information released at the time of the issue Theoretical post-rights price Market capitalisation before the rights issue + Proceeds of rights issue ÷ Total number of shares in issue post-rights

12. Bonus issue • In a bonus issue, retained profits are capitalised to give new shares to the shareholders, in proportion to their existing holdings • The par value of the shares remains the same • No new cash is received by the company • The theoretical price after the bonus issue can be calculated. The actual price will differ from this due to investors’ views on the information released at the time of the issue Theoretical price after the bonus issue Market capitalisation before the issue ÷ Total number of shares in issue after the bonus issue